Week Ending January 27

How will the EU’s ban on fuels affect the refined product (and oil) market?

Oil posted a weekly loss after fluctuating between gains and losses. March ‘23 WTI fell $1.96 to settle at $79.68/Bbl. Expectations of a recovery in Chinese demand and an uptick in mobility continue to support crude prices. Also, sanctions against Russian petroleum products are set to take effect on February 5, causing renewed supply concerns.

Chinese authorities announced that the number of virus-related deaths and hospitalizations is now 70% lower than peak levels in early January. The decrease in severe cases could bolster the nation's fuel consumption.

Chinese oil consumption is expected to set a new record this year as the nation's daily demand, which fell last year, may rise by 0.6-0.8 MMBbl/d, per the EIA. China alone accounts for over half of the EIA's projected global demand growth of 1 MMBbl/d for 2023.

The EU and G7 nations are in the planning phases for a price cap on Russian petroleum products that will go into effect on February 5, along with other sanctions. Bloomberg reported that the bloc is mulling a $100/Bbl cap on premium Russian oil products like diesel and a $45/Bbl cap on cheaper products like fuel oil, though discussions are still ongoing.

AEGIS notes that if EU members cannot reach a consensus by February 5, the full ban on Russian petroleum products will go into effect, likely tightening the fuels markets. In the U.S., that timing could stack with the effects of what is likely a large refinery-outage season.

AEGIS believes price risk is skewed to the upside in 2023 as the risk of supply shortfalls outweighs demand risks. Therefore, AEGIS hedging recommendations for crude oil remain costless collars for 2023 and 2024. A collar would set a price floor but allow for more upside participation, compared to a swap, if prices realize higher. The upside exposure afforded by the structure makes it very popular among our clients in bullish markets. However, if prices have shrunk close to your budget levels, let’s instead talk about a mix of swaps and collars that will give you the precise amount of protection you need.

Natural gas prices continued to plummet this week, with the February contract falling below $3/MMBtu, but bouncing back for a final settle of $3.109.

Gas had touched a new 19-month low of $2.832 during the day Friday. Further, the selling pressure has not been isolated to the front of the curve as the Summer ’23 seasonal strip fell 14c this week to $3.17, and the Winter ‘23/’24 strip declined by 20c to $4.07.

While our outlook still calls for a looser supply-demand picture over the next year, these lower prices may lead to some adjustments in the market. On the supply side, lower gas prices may incentivize producers to slow their production growth or scale back on new drilling. For example, in 4Q22, Chesapeake Energy said it would reevaluate its drilling activity if gas prices fell below $4/MMBtu. While production from the Permian may continue to grow as long as there is takeaway capacity, gas-focused regions such as Haynesville and Appalachia may experience a slowdown in drilling activity.

Lower gas prices may also lead to more consumption by the power sector. This is because lower gas prices normally incentivize using gas for power generation over coal. We will continue to monitor this in the coming months, especially during the summer, as the primary use of gas switches from space heating to electricity generation.

Given the selloff, it is crucial to evaluate your budget goals when determining potential hedges and structures. Forward prices in the $3-$4/MMBtu range may seem low compared to where they were trading a few months ago, but they are still elevated compared to averages from the past five years. We continue to recommend swaps in the summer and collars in winter. This week we reached out to some clients who had previously sold calls as part of a collar. Some can buy back the calls and potentially sell new calls at a lower strike. Depending on the combination of strikes, the trade can allow the hedger to collect a premium at the cost of having a lower cap (call strike) price.